Riches and reality checks in Saudi Arabia

What sort of economic legacy has King Salman inherited from Abdullah? Published in The Gulf, April 2015

When King Salman took the throne in January this year he immediately announced a $29 billion spending spree, worth as much as 4.3 per cent of the country’s gross domestic product (GDP) according to estimates by ratings agency Fitch. All Saudis employed by the state received a two-month salary bonus, and students and others also gained a hand-out.

It certainly gives the impression of a spendthrift state, yet Salman has come to power at a time when oil prices are relatively low and the fiscal pressures on the Saudi exchequer are greater than for many years. The reality is that the king is likely to be faced with some tough economic choices in the years ahead. The largesse he showed on coming to power is not something he will be able to repeat very often and, in some ways at least, he will have less room for manoeuvre than his predecessor.

Abdullah was king for just under a decade, from August 2005 to January this year, although he had been the de facto ruler for almost ten years before that, following a stroke suffered by King Fahd in November 1995. In 2005, Saudi Arabia’s population was a little over 23 million, oil prices were averaging around $54 per barrel and government expenditure was 30.5 per cent of GDP. In the following years the oil price boomed, which filled the government’s coffers and provided for a large rise in spending.

Today the population is closer to 30 million and government spending commitments reached 40 per cent of GDP last year, according to the IMF. The need to provide schools, hospitals, jobs, houses and more besides remains acute, but the lower oil price means that government revenues are taking a hit.

The fiscal pressures are not immediate, however. A huge amount of savings were built up during the oil boom of the last decade. The Saudi Arabian Monetary Agency (SAMA), the country’s central bank, had $730 billion in foreign reserves at the end of January, according to local investment house Jadwa Investment. In addition the government has very low debt levels, with gross government debt of just 2.6 per cent of GDP, according to the IMF.

All this means the government can continue spending even if oil prices stay low for some time. And if it doesn’t want to run down its savings too quickly there will be plenty of appetite for sovereign debt among local banks and international investors.

Nonetheless, the mismatch between spending and revenue highlights the main weakness of the Saudi economic model - namely it’s overwhelming reliance on oil revenues, something that did not change under Abdullah. Oil accounts for 90 per cent of government revenues, 80 per cent of current account revenues and 40 per cent of GDP, according to Fitch. The fall in oil prices led another ratings agency, Standard & Poor’s (S&P), to lower its outlook for the Saudi economy from stable to negative in early February.

Unsurprisingly, given the dominant role that hydrocarbons plays in the economy, the fall in oil price is leading to slower economic growth. London-based research firm Capital Economics estimates that the annual growth rate slowed to two per cent at the start of this year. “This slowdown has been relatively modest,” notes Jason Tuvey, Middle East economist at the firm. “We expect GDP growth of 1.5 to two per cent in 2015-16. This is by no means a disaster, but it is extremely weak by past standards.”

Within Saudi Arabia there are few obvious signs of concern. In February the purchasing managers index produced by Markit Economics, which measures activity in the non-oil economy, hit a four-month high of 58.5 points. Anything over 50 points in the index denotes growth in activity. The longer that oil prices stay low, however, the greater the likelihood that the non-oil sector will also slow.

Another aspect of the economy which did not substantially change during Abdullah’s reign is the fact that Saudis continue to show a marked preference to work for the public sector. Efforts towards Saudisation of the private sector were redoubled in the latter years of Abdullah’s rule, with crackdowns on illegal immigrants and the threat of fines for companies that didn’t employ enough locals. Huge investments were also made to improve the standard of education so that Saudis were better prepared for the world of work.

Yet many private businesses still need to be convinced that it makes sense to hire locals when foreign workers are often cheaper and more efficient. Saudis only fill 15 per cent of private sector jobs, according to Fitch. That is the highest level for at least a decade, but it is still low.

There is, of course, a limit to how many jobs the state can provide directly and the net result of all this is that unemployment among Saudis remains high, despite the fact that just 20 per cent of Saudi women and 55 per cent of men are in the labour force. According to Jadwa, the unemployment rate for Saudis aged 15 or over was 11.7 per cent last year.

Another factor behind the high jobless rate is the structure of the population. The country is not quite as youthful as it was when Abdullah took power but it remains young. In 2005 around 34 per cent of the population was aged 14 or younger. Today the proportion is 29 per cent. That represents a big headache for the authorities in terms of job creation in the coming years.

The task would be helped by greater diversification, to reduce the economy’s reliance on oil income. This is an issue not just for Saudi Arabia but for the rest of the GCC too.

“Economic diversification does matter,” says Tim Callen, assistant director of the Middle East department at the International Monetary Fund (IMF). “Oil is a volatile commodity, so you’re leaving yourself vulnerable by relying on a volatile commodity. These [GCC] countries need to create jobs. The population is young and growing. The oil sector itself doesn’t employ a lot of people so the question is where are those jobs going to come from and the non-oil private sector is where, over time, the jobs are going to have to be created.”

However, diversification is hard for economies that are commodity rich, and few around the world have successfully managed it.

“The more hydrocarbons fortunes that you have the less is the drive to diversify,” says Wael Ziada, managing director and head of research at Egyptian investment bank EFG Hermes. “Also, no matter how fast you grow your economy you’ll only be growing at a certain rate. If you’re starting from a very low base and growing [the non-oil economy] every year by an average of four to five per cent, you can take a 10 to 15 year stretch and you’ll still be dependent on oil.”

The recent track record in Saudi Arabia suggests the authorities have been having some success, however. According to Fitch, non-oil private sector growth has averaged 7.2 per cent a year over the past five years and has outpaced oil sector growth for 10 of the past 11 years. That suggests that policies adopted by Abdullah were moving the economy in the right direction

While Abdullah had a reputation as a reformer, Salman is generally viewed as more conservative. But rather than going back on changes made by his predecessor, the initial signs since he took power are ones of continuity.

There has been no change to the oil production policy agreed at the last Opec meeting in November, for example, despite the subsequent falls in the price of oil. And in a speech on 10 March in Riyadh the new king said he planned to develop a more diversified economy, with an enhanced role for the industrial and services sectors. The Saudi stock market is also still expected to open up to more international capital later this year, in line with a plan launched during Abdullah’s reign.

There have also been some potentially significant additional reforms. On coming to power, the new king disbanded a number of supreme councils and higher committees and created two new bodies in their place, including a Council of Economic & Development Affairs.

This is headed by Mohammed bin Salman, the king’s son, and is likely to play a critical role in setting economic policy for the government in the coming years. One of the main issues on the council’s agenda is how the country should respond to low oil prices, but senior figures have been stressing that there will be no knee-jerk reactions.

“We are going to undertake whatever obligations the government made to the people on the issue of projects and social and other services that are provided to the people. That is not going to change,” said Prince Turki al Faisal al Saud, a former ambassador to the US, in comments made in London on 18 March. “But there is now a new higher council for economy and development in Saudi Arabia and they are looking at all of the various alternatives that the kingdom may have on budget spending, on budget allocation, on prioritising projects and so on.”

Salman will probably find that some further changes and reforms are unavoidable if he is to lead the country towards a more sustainable economic future. But the $730 billion left in the central bank’s coffers by his predecessor mean that he does at least have some time on his side.